On my blog 2019-03–doc9 for some odd reason my full reply, as pdf, was not attached/visable. Therefor the cut & past full version follows below, with the footnotes at the end.
A reply to professor De Weijs et al.
22 March 2019, Dordrecht, The Netherlands, by Bob Wessels
(professor em. University of Leiden, The Netherlands).
In a letter, dated 20 March 2019, to the European Parliament (EP) (1) University of Amsterdam scholars R. de Weijs, A. Jonkers and M. Malakotipour, criticize heavily the introduction of a Relative Priority Rule (RPR) as currently proposed in the draft Directive on preventive restructuring frameworks (Directive) (2) Professor De Weijs et al argue that the introduction of an RPR in the EU, as an alternative to the Absolute Priority Rule (APR), would amount ‘… to a Teutonic shift within private law, company law and insolvency law’. These scholars suggest that the EP – when having their vote on 26 March 2019 – should decide not to include such an RPR in the Directive.
In their letter, the authors detail their argument by referring to academic research they have conducted (3) They invite further debate, as expressed in a Belgian law blog, and pull into the debate an article written in German by professor Madaus. (4)
Their public call cannot be left unanswered. (5)
These scholars’ call should be set aside by the EP for at least five reasons.
1. Support for RPR
To understand the dynamics of the proposed Directive, professor De Weijs at al refer on the Belgian blog to ‘two underlying reports of hundreds of pages’ and the fact that just a few pages that are devoted to Relative Priority. That’s insufficient to decide to include RPR in the Directive, they argue. They make a reference to the study by the European Insolvency Institute (ELI) in its Report on the Rescue of Business in Insolvency Law, including over 100 recommendations, written by prof. Madaus and me. (6)
The authors clearly have misunderstood the independency, the goal and the impact of this study, which was published in September 2017.
It has been written for ELI, an independent non-profit organisation in the field of European development. The Report’s goal is straightforward:
‘If the reports and the recommendations are formally approved by ELI, they can be commended for use by the European institutions active in this field, Member States, organisations and associations of turnaround managers, insolvency practitioners and judges, and other groups across Europe, in the meaning of the terms of our initial engagement.’ (7)
With the approval of the ELI Council Madaus and I, as authors, have not integrated specific rules of the European Commission’s Proposal for a Directive on preventive restructuring. In the Report, the law as it is on 28 February 2017. The period between March 2017 and September 2017 was necessary for the adoption and finalisation of the Report, being subject to the process of discussion and approval by bodies within ELI. (8)
The text of the Report has been endorsed by 14 independent experts (judges, academics and practitioners) from nearly as many countries, and after a lengthy discussion was unanimously adopted during ELI’s General Assembly in September 2017 in Vienna.
As to the aspect of Relative Priority, particularly in the EU context, early Autumn 2018 the idea developed in the ELI Report has been supported in a joint study, called Best Practices in European Restructuring, written by professors from Italy, Germany, Spain and the UK. (9)
2. Overestimation of secured classes of creditors and underestimation of European business realities
Professor De Weijs et al are not fully accurate in their presentation of the APR-rule, isolated from other norms and tools proposed for business rescue, and present European business realities. They clearly seem to overlook the fact that most EU countries have more preferential creditors than secured classes. Such preferential creditors may include employees, revenue (tax) authorities (e.g. in the Netherlands), tort victims, environmental claims, etc. (10) Taking into account the rigidity of the APR and the large number of preferential creditors, the adoption of a restructuring plan, fully satisfying such creditors would be highly unlikely. Essentially, any ‘privileged’ class of creditors could frustrate (veto) an otherwise value-creating restructuring plan. Thus, enforcing the APR may encourage hold-out behaviour of these objecting ‘privileged’ creditors.
May I add that APR has attracted criticism from its early days. The Commission tasked with reviewing the bankruptcy law in the USA, concluded that ‘…the rigidity of the [absolute priority] rule has frequently resulted in the destruction rather than the protection of interests of public investors. [These investors] are frequently eliminated from participation in a reorganization by reason of the strict application of a statute designed primarily for their protection.’ (11)
We argue that precisely because of this that the adoption of a more flexible and business-sensitive RPR is fully justified.
The legitimate interests of secured lenders are protected by a best interest test that guarantees that they will receive in a restructuring at least as much as they would be able to realize when enforcing their rights.
3. The debtor under the Directive
De Weijs et al fail to appreciate that a debtor (a business) under the proposed Directive is not insolvent. This follows directly from Article 1(a), stating that ‘[t]his Directive lays down rules on: preventive restructuring frameworks available for debtors in financial difficulty when there is a likelihood of insolvency [my italics] with a view to preventing the insolvency and ensuring the viability of the debtor.’ This is why applying the logic and rules of insolvency law, including the APR, is not justified. In the absence of insolvency, the arguments for changing the capital structure of the debtor (e.g. by wiping out shareholders and (as the case may be) junior creditors) are unconvincing.
4. Singling out one aspect, missing the broader picture
Although I understand the criticism by professor De Weijs et al, in the gamut of proposed rules and tools, the RPR is seen and analysed as one isolated aspect. The authors are rather silent on the possibility that the RPR will create incentives for early restructuring. In case of the application of the stern APR, the debtor’s company shareholders have very limited incentives to pursue restructuring as their equity will be fully wiped out. One of the major thrusts behind the proposed Directive is to ‘…enable the debtors to restructure effectively at an early stage’. (12) Since the introduction of the APR as the single option disincentivises the debtor’s directors and shareholders to use preventive restructuring frameworks, it may hamper the early restructuring of viable debtors in financial difficulties.
Notably, the US Commission cited above has also proposed that equity owners should be able to participate ‘…if their future contributions, e.g., continued management, [were] essential to the business.’ (13) I share this approach and believe that incentivizing the debtor’s directors and shareholders to use preventive restructuring frameworks as early as possible fully complies with the objectives and spirit of the proposed Directive.
This is particularly so for small and medium-sized enterprises, in which the skills, the connections of management and shareholder(s) and their understanding of (regional) circumstances play a crucial role. The proposed Directive highlights that ‘[f]or the purposes of its implementation, the restructuring plan should make it possible for holders of equity in micro, small and medium-sized enterprises to provide non-monetary restructuring assistance by drawing on, for example, their experience, reputation or business contacts’ (Recital 29a of the proposed Directive). When, as a result of the APR, equity is wiped out, this objective will never be achieved.
5. It is not about insolvency law as we know it
Professor De Weijs et al’s contention is that a drastic move to include the RPR is (thus the Belgian blog) ‘… to jettison the most fundamental rule of reorganization from the future EU framework of reorganization.’ With all respect, this observation is based on a misconception of what actually happens in business reality. An absolute norm, such as the APR, cannot serve as a starting point for discussion on what is necessary for a balanced system of business restructuring. It is a specific (be it an important) ’insolvency’ norm which has value in a specific market and under specific circumstances. Such an uncompromising norm, however, should not hijack a debate which in the end is not about (or not only about) protecting strong vested rights (of banks or certain categories of investors), but one giving chances to viable businesses.
This all is not an alleged ‘… Teutonic shift within private law, company law and insolvency law’ (letter to the EP) or ‘… a takeover of all other fields by European (Pre-) Insolvency Law’ (blog), rather it is a search for a new balance between insolvency law, company law and contract law, also based on societal desiderata related to, inter alia, protection of employment and maintenance of business activity. Where restructuring and insolvency laws legislate for business rescue, a careful balancing exercise will still need to take place between the interests of all of the various parties involved: the debtor, its creditors, its members or shareholders, with a view to the broader interests of society and the economy as a whole. (14)
Evidently, the cited scholars acknowledge that in the proposal, the aspect of the RPR is indeed an option. Therefore, we would argue, if Member States believe that it is not a good option, they are free to choose the APR. I fail to see any role of the European Parliament in this respect. Having two options (APR and RPR) creates regulatory competition between the Member States and should ultimately lead to the best results in terms of efficiency. Leaving just one option (ie APR) might impose an inefficient procedure upon all Member States without the business market itself having a chance of operating as a potential corrective.
The authors’ public call to the European Parliament to reconsider the EU adopting the RPR is unavailing in at least two ways: (i) EU politicians should not be consulted nor be invited to intervene in a legal academic debate, and (ii) if choices are to be made, the ball is in the park where it belongs, that of the EU Member States.
Footnotes
1 Available at drive.google.com.
2 Proposal for a Directive of the European Parliament and of the Council on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30 – Confirmation of the final compromise text with a view to agreement, Dec. 17, 2018, Council Paper 15556/18, available at data.consilium.europa.eu.
3 See R. de Weijs, A. Jonkers and M. Malakotipour, “The Imminent Distortion of European Insolvency Law: How the European Union Erodes the Basic Fabric of Private Law by Allowing ‘Relative Priority’ (RPR).” Available on: papers.ssrn.com.
4 A reply to professor Madaus “The new European Relative Priority from the Preventive Restructuring Directive – The end of European Insolvency Law?”, 15 March 2019, available at corporatefinancelab.org.
5 De Weijs et al. draw heavily on academic research of US professor Baird and they attach to their letter a letter of Baird, who concludes that the proposed European Directive seems to have profoundly misunderstood the essence of relative priority. With respect, but I fail to see the relevance of an academic debate in light of this letter to the EP.
6 Bob Wessels and Stephan Madaus, Instrument of the European Law Institute – Rescue of Business in Insolvency Law (September 6, 2017). Available at www.europeanlawinstitute.eu.
7 ELI Business Rescue Report, p. 8.
8 ELI Business Rescue Report, p. 5ff.
9 Available at www.codire.eu, see at p. 45ff.
10 For more on the diversity of ranking of claims in the European context, see Study on a new approach to business failure and insolvency: Comparative legal analysis of the Member States’ relevant provisions and practices, University of Leeds, 2016, p. 112.
11 Bankruptcy Commission of the United States, Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. 137, 93d Cong., 1st Sess. (1973) at 256. Discussed in B. Markell, Owners, Auctions, and Absolute Priority in Bankruptcy Reorganizations, Articles by Maurer Faculty. Paper 2061, p. 87.
12 Recital 2 of the proposed Directive.
13 Bankruptcy Commission of the United States, Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. 137, 93d Cong., 1st Sess. (1973) at 258.
14 See ELI Business Rescue Report, p. 103.